Latvia’s euro ambitions undeterred by Cyprus bailout

News

 

Despite the deepening eurozone crisis, Latvia has formally applied to become the 18th member of the single currency by January 2014.

But the hectic Cyprus bailout has forced many to ask why Latvia still wants to join the euro.

There are a number of similarities between the two small economies, particularly with both countries marketing themselves as regional financial centres.

Most Latvians are unenthusiastic about swapping the lats for the euro, but the government and the central bank strongly support the move.

They say it will attract foreign investment and lower interest rates.

Latvia has also been encouraged by the positive performance of neighbouring Estonia, which joined the currency club in 2011.

However, Alf Vanags, Director of the Baltic International Centre for Economic Policy Studies, says that even if most Latvians are against the euro, the government does not have the option of backing out.

“The Bank of Latvia is ruled by a governor, who is religious about the euro,” he says.

In addition, eurozone entry has guided many of Latvia’s economic policies over the past years, including tough austerity measures. “If the government says that it’s not a good idea after all, people will ask, why all this pain?”

In a recent interview with Euronews, Latvian Prime Minister Valdis Dombrovskis came out in strong defense of the euro currency.

“I would not say that this [current crisis] is a euro-crisis; it is not a crisis of the euro as a currency. If you look at the euro as a currency, it is stable, like the US dollar or the Japanese yen or other global currencies…[In reality, this crisis] is a financial and economical crisis in certain eurozone countries.”

 

Cyprus spillover?

But is there any chance that what happened in Cyprus could happen to Latvia?

Financial news service Bloomberg reports that financial services constitute 40 per cent of the Cypriot gross domestic product (GDP) compared with around 3-3.5 per cent in Latvia.

The Reuters news agency also reports that Cypriot bank assets were eight times the island’s GDP; in Latvia that figure is ‘only’ 130 per cent. However, about half of all deposits in Latvian banks are from non-residents.

However, in 2009 the Latvian government decided to give all non-EU citizens the right to a residence permit if they invested at least €144,150 in Latvia – a provision that is likely to conceal the real share of deposits held in Latvia by persons from outside the EU.

Regulations have been tightened up since 2008, when the mass withdrawal of foreign cash left Latvia without 40 per cent of its international reserves.

As a result, banks serving foreign clients are now required to invest their deposits in liquid assets.

Still, foreign deposits rose by a quarter from 2010 to 2012, bolstered by Russian and other Commonwealth of Independent State (CIS) investors moving their money from crisis-hit Cyprus to Latvia, a country that is not only nearer to Russia but Russian is also widely spoken there.

Nevertheless, EU Business estimates that transferred funds from offshore accounts in Cyprus only constitute around ten per cent of non-resident accounts in Latvia.

 

Irrational fears

The Latvian economy quickly recovered from the shock of 2008, when unemployment jumped to 20 per cent, pushing many Latvians to seek jobs abroad.

To deal with the crisis, the government secured a seven billion euro loan from the IMF, which has now been repaid, although Latvia still owes money to the European Commission and various smaller lenders.

Latvia won praise for putting its economy back on track but failing banks were bailed out with public money, and government programmes, departments, civil service employment and salaries were drastically cut.

However, Vanags believes that resistance to eurozone entry is irrational – if Latvia was ever made to participate in a bailout, its contribution would not be a large burden, he says.

And whatever happens in the Eurozone, Latvia will be affected as the lats is currently pegged to the euro.

A bigger fear across Europe is Russia’s reaction to the losses imposed to its residents in Cyprus.

Russia is notorious for using trade for political goals. In 2009 it cut gas supplies to Ukraine following a political disagreement. It has been speculated that this time, Russia might freeze EU assets or heavily tax European companies in Russia.

And as pre-eurozone Latvia is under a magnifying glass, any instability could be dangerous – especially for ordinary workers.